Debate over ASEAN banking integration

As a part of the ASEAN Economic Community Blueprint, ASEAN central bank governors endorsed the ASEAN Banking Integration Framework (ABIF) on April 7, 2011.

It is based on four guiding principles: Bringing economic benefits and financial stability to individual countries and the region; allowing flexibilities by adopting a double-track implementation for ASEAN5 — Singapore, Malaysia, Thailand, Philippines and Indonesia — and the BCLMV — Brunei, Cambodia, Laos, Myanmar and Vietnam; and achieving multilateral liberalization by 2020, measured by the number of commercial banks present in ASEAN.

To ensure a successful implementation of the ABIF, four conditions have been agreed upon. First is the harmonization of regulations. Second is the building of financial stability infrastructure. Third is providing capacity building for the BCLMV. Fourth is setting up agreed criteria for ASEAN Qualified Banks (QAB) to operate in any ASEAN country with a single “passport”. For the 2011-2013 period, the ABIF is co-chaired by Malaysia and Indonesia.

In this early stage, the ABIF invites a lot of crucial debates. The first is about the definition of “integration” and its benchmark indicators. Essentially, banking integration can be measured by price-based measures using the law-of-one-price hypothesis (e.g. convergence of retail interest rates) or quantity-based measures (e.g. commercial presence, cross-border bank flows, foreign bank assets-to-GDP ratios and market share of foreign banks in domestic markets).

In the language of the ASEAN Framework Agreement on Services (AFAS), banking integration can be measured by cross-border bank flows, consumption abroad, commercial banks presence and the movement of natural persons. Currently, the ABIF concept of integration is the commercial presence of QABs and it has become the benchmark. This is highly debatable. Is a commercial bank’s presence a measure of banking integration that indicates how much the ABIF has brought about economic benefits and financial stability?

The aforementioned conditions may look contradictory to the AFAS, which promotes services liberalization. It may look contradictory since the ABIF may increase regulatory and prudential barriers instead of promoting banking liberalization. But, we see the ABIF as “AFAS+”. While the AFAS promotes banking liberalization, the ABIF provides the “soft infrastructure” (harmonized regulation) and “hard infrastructure” (financial stability infrastructure).

Then there are the benefits, opportunities, costs and risks of the ABIF. It is passé to think that financial integration is always good. To think this way only brings a “feel-good” effect. ASEAN banks have learned a lot from the European banking crisis and the same should apply to banking integration.

In the short term, theoretically, the ABIF should bring the promised benefits of economies of scale, a bigger market, technological transfers, information sharing and the costs of “tied hands” — the inflexibilities to respond to domestic issues.

In the long term, the ABIF should bring opportunities to achieve stronger regional growth and accelerate poverty reduction, and reduce systemic risks, contagion effects and financial instability. A comprehensive study to assess the trade-off between the benefits and opportunities and the costs/risks is urgently needed.

There are also the strategies to maximize the benefits and opportunities and minimize the costs and risks. We think that ASEAN should accelerate the operation of a regional financial safety net. The current ASEAN+3 (ASEAN, China, South Korea and Japan) Chiang Mai Initiative Multilateralization (CMIM) is not yet operational and possess a lot of inconsistencies.

For example, the likely donor countries (the +3 countries) are still reluctant to de-link the CMIM with the International Monetary Fund, because they would otherwise carry a bigger burden to bail out troubled countries. Besides, the CMIM only deals with crisis prevention and resolution, not crisis management protocols.

ASEAN also should be re-thinking the differentiated impacts of the ABIF on ASEAN5 and the BCLMV. The ABIF stock-take has shown that there are wide gaps in some areas of regulations and financial stability infrastructure. Some studies have also shown that cross-border bank-lending flows to countries with better political stability, less corruption, more efficient government policies and high-quality legal systems.

Moreover, less financially developed countries may not be able to bail out large international banks, deterring international banks from entering those markets. Hence, integration may not result in capital flowing to less developed countries with generally poorer institutional qualities.

ASEAN should learn from the success stories of member countries.

The last crucial debate is how Indonesia should position itself. With its large domestic market, the rising number of middle-class and profitable banks, Indonesia is “sexy”. Its foreign equity participation (FEP) limit, according to the existing regulation, is one of the highest in the region, 99 percent.

It is natural that Indonesia wants to protect its domestic market, demand reciprocal treatments and even revert its FEP. On one side of the spectrum, Indonesia should prioritize its domestic interests, such as by protecting its domestic market until it increases its banking competitiveness to compete domestically and be able to penetrate foreign markets. On the other side, Indonesia should fully support the acceleration of the ABIF even before it increases its banking competitiveness and hence, may lose its market to foreign banks.

Regardless of which stance it takes, we believe that there are a few foregone conclusions. First, the soundness and credibility of domestic policies are no substitutes for any regional commitment, although at times when domestic policies are “stuck”, regional commitments can help to “tie hands” and place external pressures.

Second, authorities should not rubber-stamp how integration works since it will not be sustainable. Instead, they should facilitate it, but still let the market work without imposing a strict benchmark.

Third, regardless of whether or not the ABIF will be successful, the ASEAN banking sector will be more integrated, especially since it can reduce dependence on the European and American markets. Hence, there is no excuse for ASEAN countries to not prepare for this.

Joko Siswanto is a senior researcher at Bank Indonesia. Maria Monica Wihardja is a researcher at the Centre for Strategic and International Studies and a lecturer at the University of Indonesia. She is currently on leave to work as a consultant for Bank Indonesia. These views are personal.